Most traders will say that they are purely technical traders and then use that as an excuse to avoid following fundamentals. Such ignorance can be expensive. Forex traders who know how to follow the smart money and understand how to read the clues the markets and the professional market participants provide, can make much better trading decisions.
The following 3 economic indicators and market tools provide insights into financial activity of professional investors and smart money.
COT
The Forex spot market is a decentralized financial market which means that there is no keeping track of trading activity as a whole. However, when trading currency futures through an exchange, it is possible to see who is trading, what they are trading and to which extent.
The COT (Commitment of traders) report comes out weekly and it shows the activities of different market participants. Especially the Forex trading activities of the non-commercial traders, which are large speculators, hedge funds, banks and alike can be very interesting for Forex spot traders. Non-commercial traders, which are large speculators, hedge funds, banks and alike can be very interesting for Forex spot traders.
Bonds
Most Forex traders never pay attention to government bonds and the fixed income market which can be a big mistake. As traders, and especially as Forex traders, you have to pay attention to the flow of money and government bonds can tell you a lot about that.
When risk in the financial markets is perceived as high (in terms of political instability or a contracting economy, for example), investors will unwind their stock positions and look for “safer” and less volatile alternatives to “park” their money. Investors looking for safe-havens typically invest in currencies such as the Swiss Franc or the Japanese Yen, or government bonds. The risk that the US or the Euro-Zone won’t be able to repay their debt is very low – although it is possible.
When investors pile out of stocks, the prices of stocks fall, bond prices rise and the bond yields fall.
Bond yields and currencies usually move in the same direction. When the yield goes up, it becomes attractive to invest in that country to get a higher return on your money. And when bond yields fall, in times of uncertainty, the currency of that country tends to fall as well since the demand for that currency is going down and investors are looking for alternatives.
GDP and Unemployment
Many traders are aware of the importance to the “famous” economic variables such as GDP and unemployment rate. However, most Forex traders just watch the initial report and the release of the numbers and try to trade the news, and afterwards forget about it again. The professional traders use those numbers to determine the long-term trend and the overall market sentiment.
Especially the unemployment rate can be a great “predictor” for longer term trends. When the economy is doing well, more people will have a job and unemployment goes down. This typically also leads to a higher GDP and positive economic data leads investors to believe that a raise in interest rates is likely in the future because of increased spending activity.
Interest rates are arguably the most important factor when determining currency rates and rising interest rates typically lead to an appreciating currency because of increased demand for that currency.
The examples above show why it can pay off to follow the macroeconomic variables. Knowing what the smart money does, how the big players are positioned, when risk is perceived as high or low, knowing where the money flows and how the economy does is essential for Forex traders.
Amateur traders often believe that it’s all about technical analysis and although it can be a great part of your trading, the professional always understands the bigger picture.